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UPDATE 2-U.S. Treasury's Mnuchin urges Congress to lift debt limit before recess

recess@ (Adds comments from lawmakers on debt limit)

WASHINGTON, July 26 (Reuters) - U.S. Treasury Secretary Steven Mnuchin urged Congress on Wednesday to raise the federal debt limit before lawmakers start their August recess, to avoid higher interest costs to taxpayers and market uncertainty about a potential default.

Maintaining U.S. creditworthiness is of the "utmost importance" and the United States must pay its bills on time, Mnuchin told a Senate Appropriations subcommittee.

"As I've suggested in the past, based upon our best estimate at the time, we do have funding through September, but I have urged Congress to take this up before they leave for the recess," Mnuchin said.

However there was little sign Congress would heed Mnuchin's call, at least for the moment. The House of Representatives is due to start its recess on Friday with no hint of movement on the issue, while the Senate is consumed with trying to pass a healthcare overhaul bill.

That could leave the debt limit unaddressed until Congress returns on Sept. 5, perhaps one month before the Treasury runs a real risk of not being able to pay all of its obligations.

The last extension of the federal borrowing limit expired in March with total debt of around $20 trillion, but the Treasury has extended its ability to issue debt by employing extraordinary cash management measures, including deferring reinvestments in federal employee pension funds.

But short-term Treasury bill markets have grown nervous about the potential for the Treasury to exhaust its borrowing capacity by mid-October, sending yields higher and crushing demand for a recent 3-month bill auction.

The situation is costing taxpayers money and stoking market uncertainty, said Mnuchin, a former banker and Hollywood film financier.

"Right now effectively, as opposed to borrowing in the market at lower rates, we're borrowing and making our trust funds whole at slightly higher rates, so there is a real cost to doing that," he said. "There's also an implied cost of uncertainty into the market. And the longer we wait, that more that uncertainty will be."

Senator James Lankford, a Republican, said at the hearing that his best estimate, derived through working with Treasury officials, was that the use of extraordinary measures would amount to about $2.5 billion, largely because the government would have to cover interest owed to the affected pension funds.

Mnuchin did not dispute that estimate.

Lawmakers showed varying levels of concern on Capitol Hill this week as the Senate focused on trying to pass a bill to repeal and replace the Affordable Care Act, known as Obamacare.

"Right now, my focus is Obamacare," said Senator Ted Cruz when asked on Tuesday if the lack of action on the debt limit was a concern. Cruz led fellow Republicans in 2013 to demand spending cuts as part of a fiscal fight that led to a 16-day partial government shutdown.

Another fiscal conservative senator, David Perdue, said however he would prefer that Congress stay in session in August to deal with raising the debt ceiling, adding: "We've just got to get it done."

Senate Majority Leader Mitch McConnell wants to pass a debt ceiling increase but does not have timing nailed down, a spokesman said. (Reporting by David Lawder; Editing by Dan Grebler, Meredith Mazzilli and Frances Kerry)